At the start of 2022, green shoots were beginning to bloom across a multitude of South African sectors as consumers that had been trapped in their homes for seemingly endless lockdowns finally emerged and drove pent-up demand for a range of goods and services. Interest rates were at historic lows, providing relief to consumers and corporates alike, and inflation appeared to be a temporary blip on an otherwise sunny horizon. As we look to the finance minister, and the National Budget Speech to be delivered this year, it is striking what a difference a year can make. Central banks across the globe watched as inflation ran rampant and, as Russia’s invasion of Ukraine added fuel to the fire, had no choice but to act. The age of historically low base rates was over.
As the spectre of stagflation, or a combination of high inflation and economic stagnation, looms over the global economy, it seems almost inevitable that a longexpected wave of restructuring activity will arise, as we are seeing an unravelling of the accommodative stance enjoyed by clients from lenders over the past two years. With the prospect of permanent loadshedding, an 18.65% electricity tariff hike this year, climbing interest rates, low growth and high inflation, all placing additional stress on the economy; the question is which form the looming restructuring activity will take.
For companies finding themselves in financial distress, whether a liquidation will be the only option left on the cards will be materially influenced by the speed with which management turns to address the challenges and involves the right specialists for assistance. A recurring theme in the Deloitte Restructuring Survey is the fact that if restructuring negotiations are triggered too late, the options available for recovery are limited.
Although industry practitioners are expecting a marked increase in filings for business rescue, there is evidence of a widening trust gap between practitioners and their stakeholders. This is driven in part by low success rates, experienced especially by lenders, as well as the perceived suitability of business rescue practitioners (BRPs) followed closely by a lack of post-commencement financing (PCF) as a cause of failure. This negative perception of business rescue in South Africa needs to be addressed, as it leaves only liquidation as a formal restructuring path if business rescue is not to be trusted.
However, business rescue’s struggles have given rise to enhanced opportunities for distressed mergers and acquisitions (M&A), as it is rapidly gaining pace in being the preferred exit route from distress. In the last year, the rise of distressed M&A, especially when used as an exit strategy, has become evident. BRPs were the prominent stakeholders that indicated that distressed M&A played a greater part in their portfolios compared to any other stakeholder.
Commercial banks, possibly given the trust issues of business rescue, also expect greater distressed M&A activity in their stressed portfolios with 31% of commercial banks indicating that more than 25% of their stressed portfolios undertook distressed M&A in the past year, which is expected to rise to 38% over the next year. The C-Suite also clearly see the opportunity that distressed M&A will bring as there is an expectation that competition will increase for distressed assets. Not only is this highlighted through our survey results, but also in the analysis of Companies and Intellectual Property Commission (CIPC) business rescue statistics and Stats SA’s insolvency and liquidation statistics.
Distressed M&A can, and often does, go hand-in-hand with business rescue. When our survey respondents were asked to make one recommendation to improve business rescue legislation, the ability to conclude a "pre-pack" business rescue was ranked in the top three options behind establishing a dedicated commercial court and almost equal with clarity regarding the ranking of PCF. A "pre-pack" business rescue facilitates an expedited transaction in the rescue process.
Ultimately, one could argue that a transaction in business rescue through a distressed M&A would achieve both objectives of business rescue. Not only would one rescue the business and provide opportunity for continued trade for creditors, but also ensure that creditors achieve a better result than in liquidation through the distribution of proceeds to the pre-commencement creditors. This can however only be achieved when all stakeholders pull together at speed to achieve the desired outcome. One regulatory milestone that needs to be addressed in order to allow for the required speed of execution in these situations is the clearance by the Competition Commission. Respondents to our survey have indicated that those deals in more accommodative jurisdictions should be more successful than others as regulatory risk remains, in their opinion, the greatest challenge. A more commercial approach, adapted to the situation at hand, by the Competition Commission will facilitate a faster rescue process and thus significantly improve trust in the turnaround regime and the likelihood of a successful outcome.
There is clearly much work to do in improving trust between BRPs and their stakeholders, with stakeholders expressing a clear desire for regular, honest communication and robust regulation.
However, it must be acknowledged that the ability to utilise business rescue as a tool to save struggling businesses is only available to companies and close corporations and is generally considered too expensive an option to consider for incorporated micro, small and medium enterprises (MSMEs). With approximately 50% of our economy made up of MSMEs this means that liquidation or sequestration are generally the only options available.
The notion of a second chance economy must provide a safe haven for all size entities; and in the absence of insolvency legislation reform (which is so desperately needed), the MSMEs will be looking to the finance minister for relief measures to assist with the prevailing economic headwinds to stay any decision to enter into liquidation. Already South Africa has the highest unemployment rate in the world, and therefore job preservation must become a key objective moving forward in the next financial year.